Colm’s columns

Colm Rapple
Irish Mail on Sunday, August 8, 2010

Some of the substantial awards made by the Financial Services Ombudsman to investors who lost money as a result of bad advice from service providers are not being paid out as a result of flaws in the regulatory system. The Ombudsman has drawn attention to the problem but no-body seems in any hurry to do anything about it.  It’s yet another example of how little has changed, particularly at that level of financial regulation that impinges directly on consumers.

Many of the complaints upheld by the Ombudsman over the past year or so relate to bad or inadequate investment advice. Some of the awards made were substantial. We don’t have details but the advisers involved presumably range from employees of banks and insurance companies to small broker type operations.  Awards can be appealed to the High Court and there are individual cases involving as much as €700,000 waiting to be heard.

Some of the advisers involved have gone into liquidation. But others, including some of those with Court appeals outstanding, have indicated that they won’t be able to pay because their professional indemnity insurance won’t cover them. According to the Ombudsman some advisers are having difficulties in renewing their professional indemnity policies.

That has to be of concern to all financial advisers and all of their customers.  One easy answer would be to have Ombudsman awards covered by the Investor Compensation Scheme. But that will require legislation and that will take time. The EU Commission is preparing a directive on this area and the Department of Finance is waiting for it before amending the Irish law.

In the meanwhile, consumers have reason to be wary of all financial advisers but particularly smaller operations that might be more reliant than banks or insurance companies on their professional indemnity insurance to meet any liabilities arising from complaints to the Ombudsman.

That’s not how it should be, since there is no reason to believe that the advise given by small independent advisers is likely to be less good than that given by employees of financial institutions.

It sounds like a problem that should be of major concern to the Financial Regulator.  Unfortunately that doesn’t seem to be the case.

I e-mailed the Regulator’s press office

“Hello,

In his recent report the Financial Ombudsman refers to the failure and/or inability of some financial advisers to pay the compensation awarded and the refusal of some professional indemnity insurance companies to pay.

What has the Financial Regulator done about this?

Has any action been taken to prevent such advisers from continuing to trade?

Are any checks taking place on whether other advisers are effectively insured for professional misconduct? Are any major financial institutions involved?

Can I speak to someone about this please.

Regards”

The response wasn’t very illuminating. It simply repeated what had been in the Ombudsman’s report

“We are aware of the concerns raised by the Financial Services Ombudsman. However, we cannot comment in relation to supervisory matters involving individual firms. Any requirements in relation to establishing an investor compensation fund for paying unpaid compensation awards funded by the financial services sector would require legislative changes by government.”

Regards,

Five e-mails later, having asked again about possible inadequacies in indemnity insurance I got the following response:

“No - the regulator has not identified policies with inadequacies in this regard. During a review of PPI (professional indemnity insurance) providers, insurers were asked to confirm whether there are specific terms under which they will not make a payment on a claim further to an FSO (Ombudsman) award.   The results showed that there are no specific exclusions for FSO awards under PII cover.   A PII provider may refuse to indemnify policyholders in relation to an FSO award where the policyholder has breached one of the terms and conditions of the policy (obviously this would apply to any breach of terms and condition not just those which led to an FSO award).   In some cases the PII providers will not cover instances where a fine had been imposed against the policyholder.”

So, while the indemnity policies are considered adequate by the Regulator, there is still no guarantee that they will paid out when faced with sizeable awards made to investors by the Ombudsman. It’s a matter that should be of major concern to the Financial Regulator but it doesn’t seem to be.  Despite being specifically asked, the Regulator wouldn’t say if any advisers who have failed to pay awards are still operating as financial advisers. Understandably some with High Court appeals pending are still operating but what about the others?

The Financial Ombudsman scheme is aimed at protecting consumers against the worse excesses of the financial services sector and, a lot of the time, it does that very efficiently. But unfortunately there is no guarantee that the Ombudsman’s awards will be honoured, even with compulsory professional indemnity insurance. It is not a problem of the Ombudsman’s making .  Rather it’s a problem for the Regulator to solve but with a little more urgency than it seems to be applying at present.

Colm Rapple
Irish Daily Mail April 9, 2009

The Government has ruled out nationalising the banks but it may end up with majority shareholdings in one or more of them as a result of its decision to take over their portfolio of good, bad and indifferent property development loans. The banks are to be forced to face up to the fact that much of the €80 to €90 billion they are owed by property developers will never be repaid and that in many case the land and property titles given as security is worth far less than the outstanding loans.

That could put them in need of extra capital over and above the €7 billion already committed to AIB and Bank of Ireland. If the Government puts up extra money it will demand shares in return.

But that’s all in the future and may not arise. Even if it does, it isn’t seen as a doomsday situation although it is obviously hoped that the banks won’t need extra capital, or even if they do, that it can be sourced from private investors.

What is certain at the moment is that the Government is to press ahead with its plan to detox the banking system of all property development loans. They are going to buy those loans off the banks. Bank shareholders will take an immediate hit but the fate of bank directors and senior executives remains uncertain.

As taxpayers’ money continues to be poured into the banking system, it will remain a sore point that very few banking heads have so far rolled. Finance Minister Brian Lenihan pointed out yesterday that he expected every member of both the Bank of Ireland and AIB boards to step down at their next annual general meetings. But he has not yet decided, he said, how he will use his influence to determine the replacements.

Irrespective of who is to be in charge, clearing the banks of bad debts and uncertainty is clearly a priority. From a bank’s point of view a loan can be seen as an IOU. The borrower gets the money and the bank gets the IOU for the face value of the loan plus, if you want to be entirely accurate, a provision for the ongoing interest charges. So long as the bank believes that the loan is going to be repaid, the associated IOU is worth its full face value.

But the value of that IOU can fall significantly if the borrower gets into financial difficulties or if the security backing the loan declines in worth. The loan becomes, in bank parlance, impaired or non-performing. The bank faces a bad debt and at some stage has to recognise that fact in its profit and loss account.

The Irish banks have been accounting for some bad debts but a large proportion of the current risk on property related loans have still to be formally recognised. Thanks to a study undertaken on behalf of the Government by Dr Peter Bacon, Brian Lenihan has some idea of how much of that €80 to €90 billion in property loans can either be repaid by the borrowers or else realised by foreclosing on the loan, taking the land or property put up as security, managing and eventually selling it.

It is certainly far short of €80 or €90 billion but Mr Lenihan isn’t saying although he does point out that the initial loans were on average about 70% of the then estimated value of the securing properties. So even if the property value has since halved, it would cover about 71% of the loan.

Take for example a loan of €70 million to a developer who put up a land bank estimated to be worth  €100 million. But that land bank is now worth only €50 million while the loan still stands at €70 million. The bank has an IOU for €70 million but it is certainly not worth any more than €50 million.

Taking into account the hassle in trying to collect the debt and the fact that property values could fall further, someone buying that IOU from the bank might well be only prepared to pay €40 million.

That’s the type of assessment that the new National Asset Management Agency will have to make with regard to all the property development loans in each of the banks’ portfolios. The intention is to take over all such loans so that the Agency will end up with a significant proportion of good performing loans which, together with asset sales could yield a sufficient return to pay the interest on the money that the Government will have to raise to buy these IOUs off the banks.

The banks themselves are going to provide the money. They will lend the necessary finance to the Government and get Government bonds in return. It’s not quite as daft as it may first appear. The banks raised the money themselves to advance it to the developers. With the loans off their books, they’ll have unused resources that can be loaned back to the Government.

They’ll end up with a good quality IOU from the Government having sold off a doubtful IOU from a property developer.  That removes uncertainty, cleans their balance sheets of real and potential bad debts and leaves them free to get back to their essential task of providing credit for Irish business and individuals.

But they take a major hit. They’ll have sold their property IOU at perhaps 60% or 70% of their face value. Their reserves will be reduced and, depending on how much has been written off the value of their property loans, they may need to raise extra capital and that may have to come from the Government, if not, as mentioned earlier, from private investors.

At that stage the banks, cleaned of their bad debts, could have some attractions. If the Government does end up as a majority shareholder in one or more of the banks, the intention would be to maintain its stock market quote providing the Government with a facility to sell its investment at any time.

So how much it is all going to cost us. Both Brian Lenihan and  Michael Somers, head of the National Treasury Agency were at pains to point out yesterday how low, by EU standards, Ireland’s national debt is as a proportion of national income. Even by the most rigorous measurement Ireland’s debt/GDP ratio was 41% at the end of last year, well down on the EU average of 61%

Italy is up at 104%, France at 65%, and Germany at 64%.

If the new Asset Management Agency were to borrow €50 billion to buy the banks’ loan, our ratio could go up to 107% by 2011 but that was described by Mr Somers as manageable.

The Government did look at alternatives, in particular, an insurance scheme under which the Government would, in return for an insurance premium, underwrite the banks’ bad debts. Dr Bacon considered it at length but while he recognised an advantage in the fact that the Government wouldn’t have to initially put up any money, the taxpayer would be taking a major risk.

The uncertainty would be removed from the banks’ balance sheets but would overhang the State finances while bank executives would continue to manage the property loans. Bank shareholders might be better off, Dr Bacon conceded, but taxpayers would bear an extra risk.

Either way we are all taking a risk but urgent and speedy action is needed to get the banks working again. That’s what the Government is providing with its current plan. It is the best of the options available. We can only hope that it works.

The plan requires legislation which it is hoped to enact before the summer so it will be towards the end of the year before the new agency gets fully up and running. As the plan evolves it seems inevitable that there will be some restructuring of the Irish banking system with smaller lenders such as the Irish Nationwide Building Society subsumed into one of the larger groups.